The most popular and controversial topic this year within finance and tech circles is the rise of Bitcoin and crypto markets. Bitcoin jumped into mainstream and financial products like futures, options, funds, certificates, ETNs, ETFs are being designed to allow exposure to cryptocurrencies. The last one and a half month, we evidenced a huge growth of the crypto market, with its capitalisation surpassing $561bn from $182bn on the first day of November. The crypto market metamorphosed into a market bigger than CTAs, a $343bn well-established alternative investment market. Crypto market, according to CoinMarketCap, consists of 1360 cryptocurrencies, but Bitcoin and Ethereum account for around 67% of this market. Bitcoin market cap became almost three times bigger within two months, being a $318bn market now, with its price rising from $6,750 in the first day of November to $18,000. Ethereum was the fourth largest coin market in 2015 behind Bitcoin, Ripple and LiteCoin, but as we approach the end of 2017, the $66bn Ethereum market cap is nearly double of Ripple and Litecoin’s capitalisation combined.

STONE MOUNTAIN CAPITAL RESEARCH PERSPECTIVE VOL.46​Alternative asset management is a growing industry, where investors seek diversification to their traditional long only investment portfolios. According to PWC, a significant increase in the assets under management (AuM) of alternatives is anticipated over the next quinquennium, reaching the levels of $15.3tn with hedge funds expected to contribute one third to that amount, which means an increase of $2tn in their AuM. Main drivers of this increase are risks associated with the geopolitical environment of investments. Major determinants of the new risk framework are Brexit discussions, major country elections and Euroscepticism in Europe, the new U.S. government and FED’s policies incertitude in the U.S., and mixed signs for growth globally. Investors are in a quandary regarding their allocations amid the current uncertainty, and are scrutinizing investment opportunities that will allow them to navigate profitably during the new era. Risk and uncertainty are two coherent terms, but different, while investors are keen on identifying the key risks in their investments. The recent spike in the number strategies (both active and passive) seeking ‘alternative risk premium’ highlights the importance of identifying risk factors.

Events in bitcoin always move quickly and never more so than this week. As has been widely covered in the news, Bitfinex, the leading bitcoin exchange outside China in terms of liquidity suffered a major hack. Some 120,000 bitcoin were stolen, equating $72m USD in value at the time. Such attacks were common place in the early evolution of bitcoin, however it has been several years since one of this magnitude has occurred, made more significant by the fact that security generally in the space has been upgraded on all fronts over this period. The genesis of the attack is somewhat ironic. Bitfinex had been successfully using a cold storage protocol to secure its bitcoin, leaving only actively moving coins in its more exposed hot wallet. As part of a settlement with the CFTC, who fined Bitfinex for not allocating bitcoin directly to clients but rather pooling them in the cold wallet vault, Bitfinex moved to an allocated system. This allocated system relied on a well reputed third party, Bitgo, to provide multi-signature support to the new, account-specific, wallet. However, these wallets were not cold stored but visible online. The unknown hacker found a vulnerability in this arrangement, and it looks currently as though they obtained the API key or keys that Bitfinex used to access the Bitgo platform. Once this vector was identified the hacker bypassed all security, including delays to withdrawal, two-factor authentication and passwords, and accessed the accounts. Over a period of a few hours, thousands of individual wallets were emptied. The hack is worrying. That said the nature of bitcoin is that it is always by definition going to have an online interface at times when it is being used to trade or for transactions. Bitcoin is a work in progress and while attacks will be ever-present the lessons learned have always produced a more robust product. This however was an expensive and painful one for a large number of participants. What eight years of bitcoin history has also shown, is that bitcoin is resilient and recovers from these events. It’s hard to imagine for example, that values are several multiples higher than post the MtGox attack in 2013, after which many people declared the death of bitcoin. I am sure the ecosystem will once again adapt and go forward. In some way, with a longer term view, the events have provided an appealing entry point at the new, lower price levels.

The main question of an investor is the asset class to invest in and its respective weighting. The first dilemma comes with the approach to follow regarding the allocation: active (smart alpha via hedge funds) or passive (smart beta via ETFs). Investing in traditional indices is substituted by ETFs, a 25-year market with increasing popularity, which attracts $3 trillion and overtook the long-standing hedge fund industry in terms of assets under management in Q2 2015.

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